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Section 16 of the Income Tax Act

Section 16 of the Income Tax Act

Section 16 of the Income Tax Act
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Indian Income Tax Act 1961 provides you with multiple avenues for reducing your gross taxable income. These tax deductions reduce your tax burden especially if you are salaried.

One such tax deduction is available under section 16 of the Income Tax Act.

What is Section 16 of the Income Tax Act?

Section 16 of the Income Tax Act provides for certain deductions from the salary income. You can reduce tax incidence on your salary income with deduction under section 16 under the following heads:

1. Standard Deduction

2. Entertainment Allowance

3. Professional Tax Paid

You should note that you can avail of these deductions and deductions under section 80 when you follow the old regime of tax slabs. These deductions will not apply if you switch to the new tax slab rates under the new regime.

Deductions Under Section 16 - Explained

Section 16 of the Income Tax Act applies before your net taxable income. Thus, you will need to consider the following deductions before estimating your tax liability for the year:

1. Standard Deduction

The standard deduction is a fixed amount you can deduct from your taxable salary. You can deduct the lower of the following two:

  • Rs 50,000
  • The amount of your salary

2. Deduction for Entertainment Allowance

Additionally, you can claim a deduction on Entertainment allowance. This allowance shall be first added to your salary income under the head “Salaries”. Thereafter, you can claim a deduction on it on the following grounds:

Government Employees

If you are a central or state government employee you can claim lower of the following as deduction:

  • ₹ 5,000
  • 20% (1/5th) of Basic Salary, or
  • Amount of the entertainment allowance
a. Private Sector Employees

Deduction for entertainment allowance is not available.

b. Employees of Statutory Corporations and Local Authorities

Deduction for entertainment allowance is not available.

Note: It is important to consider the following points to ascertain the amount of entertainment allowance deductible from your salary:

1. Salary will not include any allowance, benefit, or any other form of perquisites.

2. You can't consider your expenses towards entertainment for claiming a deduction.

3. You can account for the expenses you incur out of the entertainment allowance you have received

3. Professional Tax or Employment Tax

State governments in India can levee a professional income tax. You can claim this state government tax as a deduction from your final tax liability for the year with the central government.

The maximum amount state governments can deduct as professional tax is Rs 2500 in a year. Thus, this is the maximum amount of deduction you will claim under this head.

How does Deduction Under Section 16 Work?

The government had introduced the provision of the standard deduction in the Union Budget 2018. The key benefit of this provision is that provides tax relief to salaried taxpayers. The Finance Ministry raised the limit of deduction under section 16 of the Income Tax Act from ₹40,000 to ₹50,000 in Union Budget 2019.

Before 2018, there was a provision to claim reimbursements for the transportation expenses incurred on official tours as well as medical bills. However, those deductions were limited to:

  • Medical allowance = ₹15,000 per annum
  • Transport allowance = ₹1,600 per month (i.e., ₹19,200 per annum)

Hence, the total amount you could deduct from your gross salary used to be ₹34,200 per annum (15,000 + 19,200).

However, as per the new provision of the standard deduction, you can now claim the deduction up to ₹50,000. Hence, you get an extra tax benefit of ₹15,800 (50,000 – ₹34,200). This small amount of tax benefit makes a huge impact on your net tax liability.

Click here to use - Income Tax Calculator

Example of Section 16 Deduction in Tax Calculation

Suppose the following are your salary details:

  • Basic pay: ₹ 5 lakhs
  • A.: ₹ 2 lakhs
  • Contributions towards EPF: ₹ 24,000
  • PPF Deposits: ₹ 50,000
  • Transportation allowance: ₹ 19,200
  • Medical allowance: ₹ 15,000

Gross Income = (500,000 + 200,000) = ₹ 700,000

Gross Taxable Income = 700,000 – (24,000 + 50,000) = ₹ 626,000

I. Tax Calculation Before Section 16

You could claim deductions from your gross income = ₹ 34,200

Thus, your taxable income: (6,26,000 – 34,200) = ₹ 5,91,800

Your total tax payment as per current income tax slab shall be = ₹ 12,500 (5% rate for income between ₹2,50,000 and ₹ 5,00,000)

Tax on the remaining amount = 10% of (5,91,800 – 5,00,000) = ₹9,180/-.

So, your net total tax liability:  12,500 + 9,180 = ₹21,860

II. Tax Calculation After Section 16

You can claim standard deductions from your gross income = ₹50,000

Your taxable salary income: (6,26,000 – 50,000) = ₹5,76,000

Your total tax payment as per current income tax slab shall be = ₹12,500

Tax on the remaining amount = 10% of (5,76,000 – 5,00,000) = ₹7,600

So, your net total tax liability = 12,500 + 7,600 = ₹20,100

How to Reduce your Tax Liability?

You can decrease your tax incidence on your salary income by investing in tax-saving investments.

Here are different types of tax-saving investment instruments on which you can claim deductions from your taxable income:

Tax-Saving Investments

Particulars Deduction limit (in ₹)
i. The premium of life insurance policy
ii. PPF, EPF, and superannuation funds
iii. Equity-linked saving scheme (ELSS)
iv. National saving certificate (NSC)
v. Unit Linked Insurance Plan (ULIP)
vi. Tax saving Term Fixed Deposit for at least 5 years
vii. Premiums paid for life insurance pension plans
viii. Self-contribution to NPS (National Pension Scheme)
Up to 1.5 Lakhs
Additional deduction on:
  • The contributions in NPS.
  • Contributions towards Atal Pension Yojana
  • Repayment of home loan principal (for 60+ taxpayers)
Up to 50,000

Apart from these investments, certain necessary expenses also reduce your tax liability. For example, the medical insurance premium you pay for your family or the treatment cost for your parents.

Disclaimer: This article is issued in the general public interest and meant for general information purposes only. Readers are advised to exercise their caution and not to rely on the contents of the article as conclusive in nature. Readers should research further or consult an expert in this regard

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